Government Tenants
The U.S. government holds many hats, but for some, the government is known as a more personal entity, a tenant. Within commercial real estate lies a niche subsector — government-leased investments. These unique assets have strong credit tenancy and higher renewal rates but come with their own standards as they are directly linked to a government agency. As investors battle changes in the retail landscape and a difficult lending market, securing government tenants has gained popularity.
GSA Market Overview
GSA properties refer to real estate properties that are leased or owned by the U.S. General Services Administration (GSA) and used to fulfill the property-related needs of various federal agencies. The GSA is responsible for managing and maintaining federal government buildings, which includes acquiring, leasing, and disposing of properties.
These government properties range from office buildings and federal prisons to warehouses and military installations. The GSA works closely with federal agencies to determine their space requirements, leasing or purchasing properties accordingly. The agency also oversees the renovation and repair of government buildings, as well as the demolition of properties that are no longer needed.
The General Services Administration owns and leases over 371 million square feet of space in 8,600 buildings in more than 2,200 communities nationwide.
For those buildings the GSA does not own, they rely on retail or office investors. Owners can purchase GSA-suited properties “fee simple,” meaning the land and the building is owned by the investor, but it is purchased with a government entity as the intended tenant. The GSA has leasehold rights, which results in the lease often favoring the tenant. However, because the investor is leasing to a government agency, the rent is 100 percent backed.
Why Invest in GSA Tenants
GSA investments offer several advantages to owners that have driven the sector’s popularity over time. As retail shifts in a high operational cost environment, investors seek reliable tenants, less turnover, and higher yields.
Compared to similar single tenant net lease (STNL) assets, government-leased assets can provide yields of +500 basis points over 10 years. This is due to the steady cash flow GSA buildings incur and the strong performance of specific property types like data centers. In addition, these assets provide security and high renewal rates. GSA properties offer strong credit as the federal government backs the leases. Lenders are more likely to finance these investments in the current environment knowing the borrower will receive rent and be able to pay the loan. STNL investments aren’t as attractive as they were in previous years due to the fear their credit isn’t strong enough, making room for GSA capital. Security also comes through the tenant’s long-term leases. Experts stated that GSA-leased properties had a 14.6-year lease on average due to the buildings’ purpose-built nature.
With the stability GSA real estate brings, there are also some disadvantages to being such a specialized investment. Although leases are long-term, most contracts negotiated with the GSA include an early termination clause that causes extensive underwriting obstacles. The lease renewal process is also time consuming compared to other NNN retail assets, as owners have to negotiate directly with government agencies, which often face delays. In addition, owners of government-leased assets need to be committed to the property management aspect of real estate investing, meaning the leases are full-service, and owners should expect to be responsible for long-term operating costs. Lastly, the U.S. government has announced several measures to consolidate and downsize its real estate footprint over the next decade in an attempt to reduce costs and environmental effects. This could cause issues for investors down the road as consolidations spur relocations and difficulties in finding replacement tenants.
Government agencies are conducting portfolio-wide office space analyses to identify the most cost-effective opportunities – those that best support mission attainment and customer service – to consolidate, dispose, and modernize their portfolios. Source: Office of Management and Budget
A Look into USPS Investments
Although the United States Postal Service (USPS) is its own entity under the Executive Branch and its properties are not managed by the GSA, USPS still makes for a reliable government tenant.
The United States Postal Service has been undergoing major changes over the past few years to combat decreasing revenue predictions. In 2018, JLL took over as the real estate provider for the United States Postal Service. Previously managed by CBRE, JLL now negotiates leases on behalf of the USPS for those properties rented from private owners. The brokerage also handles the sale of postal service buildings and helps lease any unused space in USPS-owned assets. This change in providers is important for investors to note, as all lease structures, terms, and negotiations will be through the third-party brokerage on the tenant side.
During this same time, the agency rolled out new lease structures that put more responsibility on the landlord. Some major changes included lessors being made explicitly responsible for maintenance of all electrical and plumbing systems, conduit, and related “components” other than those installed by the USPS. In addition, upon lease expiration, the USPS can abandon improvements placed on the premises without the requirement of compensation to the landlord for their removal and any necessary restoration.
Another update came in 2021 when the U.S. passed Delivering for America, a 10-year plan that ensures the USPS’ financial security, streamlines operations, and invests in modern technology. A major tactic of the plan was the disbursement of $10 billion in funding to aid infrastructure and customer service and implement a new pricing authority, along with the Postal Service Reform Act. According to the American Postal Workers Union, the Postal Service Reform Act has four main goals, end the retiree health benefit pre-funding mandate, add transparency to USPS’ service issues, provide prospective Medicare integration, and guarantee six-day delivery.
Out of the four key points, the pre-fund mandate will be the biggest issue tackled. The mandate stated the postal service must pre-fund all its retirees’ health benefit liabilities 75 years ahead of time, costing $5.5 billion annually over the first 10 years. This racked up a debt of $35 billion that the USPS owed the government on unpaid portions of the liabilities, making it difficult for the postal service to put any money into upgrading infrastructure or services. After enacting the Delivering America plan, the USPS is on track to break even from 2021 to 2030. The entity was previously projected to lose $160 billion during this period.
The reform act is estimated to save the USPS at least $45 billion over the next 10 years.
In another attempt to modernize the USPS and reduce costs, the agency committed to implementing an electric fleet of delivery vehicles starting in 2023. Known as the Next Generation Delivery Vehicles, the USPS stated that 75 percent of its newly acquired fleet over the next five years would be electric. After 2026, all new vehicle acquisitions will be electric.
Lastly, the insurgence of e-commerce has impacted the United States Postal Service on many levels, but one that impacts landlords is its partnership with Amazon. Widely unknown, Amazon relies on the USPS for most of their “last mile” deliveries, in turn, increasing the number of incoming packages and vehicles coming on postal service property. This has caused some lessors to take steps to mitigate potential risks of non-USPS employees onsite and put policies in place to ensure operations continue without disruption.
Why Invest in USPS
USPS investments have approximately 98 percent lease renewal rates and guaranteed rent. Leases are typically structured with a five-year lease term and the option for a five-year renewal. The largest benefit of having the USPS as a long-term tenant is its specified interest in investing back into its operations and services. The entity’s ongoing commitment to securing financial security through various initiatives ensures post offices will continue to thrive in the investment sector as revenue increases, helping property values and renewal rates.
Only about 25% of all postal facilities in the U.S. are owned by the United States Postal Service. The remaining 75% are privately owned and leased to the USPS.
Takeaways
Investing in government-leased assets is a unique opportunity within the office and retail sector that provides high-level stability and occupancy. As other retail owners face the uncertainty of tenant turnover or missed payments in a volatile market, government services owners are financially backed. The specialty asset class will face some headwinds as the U.S. government looks to consolidate properties, but the efforts will also create more competition, increasing valuations.
